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Critical Study of Mutual Funds 1.

Introduction to Mutual Funds

1.1 Origin 1.2 Concept of a Mutual Fund 1.3 Advantages of Mutual Funds 2. Organisation of a Mutual Fund

2.1 Key Players 2.2 Key terms used in Mutual Fund industry 3. 4. 5. Types of Mutual Fund Schemes Growth of Mutual Funds in India Unitholders¶ Protection 5.1Role of SEBI 5.2Role of AMFI 6. Conclusion

The purpose of establishing the Unit Trust of India was to give a fillip to equity market. The income earned through these investments and the capital appreciation realised are shared by its unit holders in proportion to the number of units owned by them. the setting up of Unit Trust of India (UTI) in 1964 marked the advent of mutual fund industry. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a UTI was established as a corporate body.amfiindia. 1. both Indian and foreign. UTI was regulated since its inception by the UTI Act. The association of Mutual Funds in India (AMFI) has officially classified the four decades of mutual funds in India into four phases.1. 1996.aspx?page=mfconcept . The first phase during the years 1963-1987 saw UTI consolidating its position by offering a variety of products and extending its reach throughout the country. Introduction to Mutual Funds 1.2 Concept of Mutual Fund 1 A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. professionally managed basket of securities at a relatively low cost. 1963 and regulations framed there under. The third phase began in 1993 with the arrival of private sector players. The flow chart below describes broadly the working of a mutual fund 1 http://www. debentures and other securities. The next phase (198793) marked the arrival of mutual funds sponsored by public sector banks and financial institutions.1 Origin In India. The fourth phase started with SEBI (Mutual Funds) Regulation. Unit Trust of India was set up by an act of Parliament. The money thus collected is then invested in capital market instruments such as shares.

Economies of Scale Mutual funds are able to take advantage of their buying and selling size and thereby reduce transaction costs for investors.asp . by choosing to buy stocks in the retail sector and offsetting them with stocks in the industrial sector. we are provided with the immediate benefit of instant diversification and asset allocation without the large amounts of cash needed to create individual portfolios. time or we can reduce the impact of the performance of any one security on our entire portfolio. Their simplicity along with other attributes provides great benefit to investors with limited knowledge. we are able to diversify without the numerous commission charges.3 Advantages of Mutual Funds2 Since their creation. By purchasing mutual funds. When we buy a mutual fund. Diversification involves the mixing of investments within a portfolio and is used to manage risk. for both large and small investors.1. is asset diversification.investopedia. These are some of the reason why one might consider investing in mutual funds Diversification One rule of investing. For example. mutual funds have been a popular investment vehicle for investors. 2 http://www.

Therefore. rather than having to thoroughly research every investment before we decide to buy or sell. In general. including backend load fees. However. . we are able to sell your mutual funds in a short period of time without there being much difference between the sale price and the most current market value. it is important to watch out for any fees associated with selling.Liquidity Another advantage of mutual funds is the ability to get in and out with relative ease. we have a mutual fund's money manager to handle it for us. This manager will use the money that we invest to buy and sell stocks that he or she has carefully researched. we are also choosing a professional money manager. Professional Management When we buy a mutual fund.

Trustees They hold assets on behalf of the unit holders in the trust. Asset Management Company (AMC) The main objective of the AMC is to float schemes and manage them in accordance with the SEBI regulations. They also form a trust and appoint board of trustees. They establish the fund and get it registered with SEBI. Organisation of a Mutual Fund There are many entities involved and the diagram below illustrates the organisational set up of a mutual fund 2. The trustees shall have a right to obtain from the asset management company such information as considered necessary by the trustees.1 Key Players Fund Sponsors They are akin to promoters of a company. The trustees enter into investment management agreement with the asset management company. They appoint Asset Management Company and ensure that all the activities of the AMC are in accordance with the SEBI regulations. They also appoint the custodian of the fund. .2.

Distributors comprise of banks.Custodian The main function of the custodian is to hold the fund¶s securities in safekeeping. non-banking financial companies and other distribution companies. Distributors/agents To send their products across the length and breadth of the country. Such prices are NAV related.2 Key terms used in Mutual Fund Industry Net Asset Value (NAV) Net Asset Value is the market value of the assets of the scheme minus its liabilities. Repurchase Price It is the price at which units under open-ended schemes are repurchased by the Mutual Fund. mutual funds take the services of distributors/agents. It may include a sales load. and record information on stock splits and other corporate actions. Registrar and Transfer Agents They maintain records of unit holders¶ accounts and transactions. Individuals constitute the agency force. collect interests and dividends paid on securities. settle securities transactions for the fund. prepare and distribute account statements and tax information. Sale Price It is the price you pay when you invest in a scheme. The per unit NAV is the net asset value of the scheme divided by the number of units outstanding on the Valuation Date. handle unit holder communications and provide unit holder with transaction services. It is also called Offer Price. . 2. disburse and receive funds from unit holder transactions.

It is also called. Schemes that do not charge a load are called µNo Load¶ schemes. µFront-end¶ load. Sales Load It is a charge collected by a scheme when it sells the units. Such prices are NAV related. Repurchase or µBack-end¶ Load It is a charge collected by a scheme when it buys back the units from the unit holders. .Redemption Price It is the price at which close-ended schemes redeem their units on maturity.

The Equity Funds are sub-classified depending upon their investment objective. as follows y y y y Diversified Equity Funds Mid-Cap Funds Sector Specific Funds Tax Savings Funds (ELSS) Equity investments are meant for a longer time horizon. these funds ensure low risk and provide stable income to the investors.1 Equity funds These funds invest a maximum part of their corpus into equities holdings. 3. private companies. These Funds carry zero Default risk but are associated with Interest Rate risk. thus Equity funds rank high on the riskreturn matrix. The structure of the fund may vary different for different schemes and the fund manager¶s outlook on different stocks. banks and financial institutions are some of the major issuers of debt papers. popularly known as Government of India debt papers. . 3.2 Debt funds The objective of these Funds is to invest in debt papers.3. These schemes are safer as they invest in papers backed by Government. Types of Mutual Fund Schemes Mutual fund schemes may be classified on the basis of their structure and investment objectives. Government authorities. By investing in debt instruments. Debt funds are further classified as: y Gilt Funds Invest their corpus in securities issued by Government.

. These funds are meant for short-term cash management of corporate houses and are meant for an investment horizon of 1day to 3 months. are a mix of both equity and debt funds. 3. These funds provides easy liquidity and preservation of capital. These funds primarily invest in short term papers like Certificate of Deposits (CDs) and Commercial Papers (CPs).y Income Funds Invest a major portion into various debt instruments such as bonds. These schemes invest in short-term instruments like Treasury Bills. These scheme ranks slightly high on the risk-return matrix when compared with other debt schemes. corporate debentures and Government securities. Some portion of the corpus is also invested in corporate debentures. CPs and CDs. It gets benefit of both equity and debt market. inter-bank call money market.3 Balanced funds As the name suggest they. Equity part provides growth and the debt part provides stability in returns. These schemes rank low on risk-return matrix and are considered to be the safest amongst all categories of mutual funds. y Liquid Funds Also known as Money Market Schemes. These schemes aim to provide investors with the best of both the worlds. They invest in both equities and fixed income securities. y Short Term Plans (STPs) Meant for investment horizon for three to six months. y MIPs Invests maximum of their total corpus in debt instruments while they take minimum exposure in equities. which are in line with pre-defined investment objective of the scheme.

preservation of capital and moderate income. . These schemes normally invest a major part of their fund in equities and are willing to bear short-term decline in value for possible future appreciation. short-term instruments. such as treasury bills. y Income Schemes Income Schemes are also known as debt schemes.Further the mutual funds can be broadly classified on the basis of investment parameters Each category of funds is backed by an investment philosophy. in the proportion indicated in their offer documents (normally 50:50). The aim of these schemes is to provide regular and steady income to investors. y Money Market Schemes Money Market Schemes aim to provide easy liquidity. The investor can align his own investment needs with the funds objective and invest accordingly. These schemes invest in both shares and fixed income securities. y Balanced Schemes Balanced Schemes aim to provide both growth and income by periodically distributing a part of the income and capital gains they earn. These schemes generally invest in safer. certificates of deposit. The aim of these schemes is to provide capital appreciation over medium to long term. which is pre-defined in the objectives of the fund. These schemes generally invest in fixed income securities such as bonds and corporate debentures. Capital appreciation in such schemes may be limited. commercial paper and inter-bank call money. By investment objective: y Growth Schemes Growth Schemes are also known as equity schemes.

. Fast Moving Consumer Goods (FMCG). Software. Under Sec. Petroleum stocks. etc. Pharmaceuticals. Investors need to keep a watch on the performance of those sectors/industries and must exit at an appropriate time. The portfolio of these schemes will consist of only those stocks that constitute the index. y Index Schemes: Index schemes attempt to replicate the performance of a particular index such as the BSE Sensex or the NSE 50.Other schemes y Tax Saving Schemes: Tax-saving schemes offer tax rebates to the investors under tax laws prescribed from time to time. e. they are more risky compared to diversified funds.g. And hence. contributions made to any Equity Linked Savings Scheme (ELSS) are eligible for rebate.88 of the Income Tax Act. y Sector Specific Schemes: These are the funds/schemes which invest in the securities of only those sectors or industries as specified in the offer documents. the returns from such schemes would be more or less equivalent to those of the Index. The percentage of each stock to the total holding will be identical to the stocks index weightage. The returns in these funds are dependent on the performance of the respective sectors/industries. While these funds may give higher returns.

The history of mutual funds in India can be broadly divided into four distinct phases First Phase ± 1964-87 Unit Trust of India (UTI) was established on 1963 by an Act of Parliament. In 1978 UTI was de-linked from the RBI and the Industrial Development Bank of India (IDBI) took over the regulatory and administrative control in place of RBI. Bank of India (Jun 90). Bank of Baroda Mutual Fund (Oct 92).47.UTI. The erstwhile Kothari Pioneer (now merged with 3 http://www.700 crores of assets under management.amfiindia. Second Phase ± 1987-1993 (Entry of Public Sector Funds) 1987 marked the entry of non.4. SBI Mutual Fund was the first non. At the end of 1993. a new era started in the Indian mutual fund industry. At the end of 1988 UTI had Rs. LIC established its mutual fund in June 1989 while GIC had set up its mutual fund in December 1990. except UTI were to be registered and governed.004 crores. Punjab National Bank Mutual Fund (Aug 89). The first scheme launched by UTI was Unit Scheme 1964.UTI Mutual Fund established in June 1987 followed by Canbank Mutual Fund (Dec 87). Also. the mutual fund industry had assets under management of Rs. Third Phase ± 1993-2003 (Entry of Private Sector Funds) With the entry of private sector funds in 1993.aspx?page=mfindustry . Growth of Mutual Funds in India 3 The mutual fund industry in India started in 1963 with the formation of Unit Trust of India. at the initiative of the Government of India and Reserve Bank of India. Indian Bank Mutual Fund (Nov 89). 1993 was the year in which the first Mutual Fund Regulations came into being. public sector mutual funds set up by public sector banks and Life Insurance Corporation of India (LIC) and General Insurance Corporation of India (GIC). under which all mutual funds. giving the Indian investors a wider choice of fund families.6. It was set up by the Reserve Bank of India and functioned under the Regulatory and administrative control of the Reserve Bank of

44. PNB. The 1993 SEBI (Mutual Fund) Regulations were substituted by a more comprehensive and revised Mutual Fund Regulations in 1996.21. and with recent mergers taking place among different private sector funds. .76.000 crores of assets under management and with the setting up of a UTI Mutual Fund. BOB and LIC.541 crores of assets under management was way ahead of other mutual funds. there were 33 mutual funds with total assets of Rs. The second is the UTI Mutual Fund. The number of mutual fund houses went on increasing. representing broadly. The industry now functions under the SEBI (Mutual Fund) Regulations 1996. with many foreign mutual funds setting up funds in India and also the industry has witnessed several mergers and acquisitions.29. assured return and certain other schemes. sponsored by SBI. As at the end of January 2003. the assets of US 64 scheme.805 crores. With the bifurcation of the erstwhile UTI which had in March 2000 more than Rs. functioning under an administrator and under the rules framed by Government of India and does not come under the purview of the Mutual Fund Regulations.Franklin Templeton) was the first private sector mutual fund registered in July 1993. One is the Specified Undertaking of the Unit Trust of India with assets under management of Rs. The Unit Trust of India with Rs. following the repeal of the Unit Trust of India Act 1963 UTI was bifurcated into two separate entities. the mutual fund industry has entered its current phase of consolidation and growth. conforming to the SEBI Mutual Fund Regulations. Fourth Phase ± since February 2003 In February 2003. 1. The Specified Undertaking of Unit Trust of India. It is registered with SEBI and functions under the Mutual Fund Regulations.835 crores as at the end of January 2003.

.The graph indicates the growth of assets over the years.

The revised regulations embodied far reaching changes in the regulation and functioning of mutual funds. Unit holders¶ Protection 5. the SEBI (Mutual Funds) Regulations. The revised regulations provide for y y y enhanced level of investor protection empowerment of investors stringent disclosure norms in the offer documents. better aware of risks and rewards y standardisation of norms for valuation of assets. Based on the comments received on the recommendations made in the paper by market participants and investors and on discussions held with the Association of Mutual Funds of India (AMFI). computation of Net Asset Values (NAVs) of schemes of mutual funds and accounting standards and policies y complete freedom to asset management companies to structure schemes in accordance with investor preferences y removal of quantitative restrictions on investment by mutual funds and replacement by prudential supervision y y replacement of vetting of offer documents by filing guaranteed return schemes by mutual funds permitted provided returns including capital were guaranteed y y indication of expected returns based on hypothetical portfolio permitted better governance of mutual funds through higher responsibilities and empowerment of trustees as front-line regulators of mutual funds 4 http://www. 1993 were revised and the new regulations notified in December 1996.sebi. so that investors are better informed.html .in/annualreport/9697/ Role of SEBI 4 During 1995-96. so that mutual funds could provide a better performance and service to all categories of investors and offer a range of innovative products in a competitive manner to match investor needs and preferences across various investor segments. better advised. SEBI had prepared and widely circulated a paper titled "Mutual Funds 2000" which identified ways to improve the working and regulation of the mutual fund industry.

One of the objectives of AMFI is to promote investors¶ interest by defining and maintaining high ethical and professional standards in the mutual fund industry. former Cabinet Secretary and Ambassador to the United States. In this process. trustees act as the first level regulators and are critical in helping to ensure the profitability and progress of the mutual funds. The new regulations have brought into greater focus the responsibilities of trustees of mutual funds who are uniquely positioned to promote the interests of the unitholders and to ensure that mutual funds are managed responsibly and ethically. 1995 as a non-profit organization.y y closer scrutiny through off site and onsite inspections code of ethics for asset management companies The impact of the new regulations was immediately felt. To assist trustees in their new role.2 Role of AMFI AMFI. Not only did the number of schemes filed with SEBI increase significantly in a short period of time. AMFI code has been drawn up to encourage adherence to . There was also a significant improvement in disclosures in the offer documents. and to set out the manner in which they could best perform this role. but also there was greater variety in the investment products offered. SEBI also continued working with AMFI so that it becomes a more effective body representing the mutual fund industry and embarks on a campaign to sharpen the industry's focus on the consumer. The AMFI code of ethics set out the standards of good practices to be followed by the asset management companies in their operations and in their dealing with investors. SEBI is using its interface with AMFI to assess the impact of the new regulations on the working of mutual funds and to examine further ways of improving the performance of mutual funds so as to restore investor confidence in them. SEBI appointed a committee under the chairmanship of Shri P K Kaul. the apex body of all the registered asset management companies was incorporated on August 22. All the asset management companies that have launched mutual fund schemes are its members. Asset management companies framed several schemes which made use of the freedom provided to them by the new regulations. 5. The trustees act independently to uphold the public trust. intermediaries and public.

standards higher than prescribed by the regulations for the benefits of the investors in the mutual fund industry . .